Japan’s alternative economics

Japan’s current growth, with 2.8% forecast for 2006, is at the forefront of western countries. It is linked to exports to emerging economies, a high level of research and development, and a refusal to follow all the economic doctrines proposed by the United States.

Japan is back. Its economy has been growing faster than at any time since the late 1980s. Consumer spending is strong; employment conditions are good. Toyota recently announced a plan to hire more than 3,000 new employees, the first time in 15 years that it has hired so many, and is poised to overtake General Motors as the world’s largest car manufacturer. As well as manufacturers, financial and service companies are doing well.

Although this recovery started four years ago, many outside Japan have not acknowledged it. One reason might be that we prefer hearing about Japan’s misfortunes, a case of schadenfreude. Japan’s recovery is controversial, thought of as a chimera because it goes against conventional wisdom.

From 1990 to 2001, when Japan was in the doldrums, its problems were attributed to its distinctive form of capitalism. Markets were said to be overregulated and protected by government, the business community was faulted for its lack of entrepreneurial spirit, corporations were criticised for being averse to downsizing and insufficiently focused on shareholder value. With the United States economy so buoyant during those years, it seemed obvious what Japan ought to do: become more like the US. Indeed, the prescriptions offered for reviving the Japanese economy contained the same ingredients that were said to have restored the US economy to health in the 1990s: deregulation, new ventures and a focus on shareholder value.

Some Japanese took the message to heart, despite the hubris of the messengers. The government of Prime Minister Junichiro Koizumi and its predecessors modestly deregulated and privatised industries such as telecommunications, transportation, energy and finance. But Japan’s approach to deregulation was different from the US: it was more akin to what political scientist Steven Vogel terms re-regulation - it maintained a role for government to stabilise new market configurations (1).

Private and public efforts were made to spur the creation of new high-tech businesses and to launch a venture capital market in Japan. Newspaper articles lionised young entrepreneurs, such as Masayoshi Son of Softbank, and Takefumi Horie of Livedoor. The door was opened to a more rugged style of capitalism in Japan. It had been considered socially inappropriate for Japanese companies to engage in hostile takeovers, but in the late 1990s corporate raiders appeared, including Yoshiaki Murakami who several times acquired stock in underperforming companies in efforts to get more cash returned to shareholders.

Finally the Koizumi government revamped commercial law to permit, but not require, US-style corporate governance, which puts shareholders at the centre of a corporation. New rules allowed companies to repurchase shares, issue stock options and adopt a US-style system of independent corporate directors.

Resistance to change

But many large Japanese corporations were reluctant to change. They blamed the country’s slow growth on policy mistakes by government, such as the sluggish resolution of Japan’s banking mess and a policy of excessive monetary stringency pursued by the Bank of Japan. Until recently these doubts were expressed quietly. Dissenting voices grew louder after 2001, when the US economy was hit by such corporate scandals as Enron and the collapse of its own bubble economy. Around this time the Japanese economy finally began to recover.

Business leaders such as Fujio Mitarai of Canon and Hiroshi Okuda of Toyota refuse to accept the idea that there is one best way - the US way - of organising an economy. Instead, companies including Canon and Toyota continue to staff corporate boards with insiders, pay executives modestly and minimise employee layoffs. As Mitarai says: “The advantage of lifetime employment is that employees absorb the company’s culture throughout their careers. As a result, team spirit grows among them, a willingness to protect the corporate brand and stick together to pull through crises. I believe that such an employment practice conforms to Japanese culture and is our core competency to help survive global competition” (2).

Mitarai’s point is that Canon derives an advantage from the difference between it and its global competitors, from the distinctiveness (the brand) of its products and from the underlying business structure that helps to produce them. A measure of scepticism is warranted here, but so is recognition that big companies such as Canon and Toyota are sensitive to social norms and seek to make the best of them. Large Japanese companies view themselves more as ongoing communities than as the property of shareholders. The community includes shareholders, but it also comprises employees, customers, suppliers and creditors. Rather than maximise shareholder value (the US mantra), managers seek to balance the community’s interests to foster long-term corporate success.

It is an imperfect corporate model. During the 1990s, when growth was slow, large Japanese companies adjusted to slack demand by reducing new hirings which, as in Europe, shifted the burden of unemployment to the young. Nor is it a model that encourages high levels of entrepreneurial risktaking. Japanese firms instead focus on products and industries where they can make incremental improvements that are facilitated by highly trained employees and a long-term perspective.

Instead of relying on venture capital to fund new firms, Japanese corporations reinvest their profits in corporate spinoffs - new firms spawned by old ones - and in research. According to the Organisation for Economic Coperation and Development, in 2005 Japan had the highest research and development intensity, as a percentage of gross domestic product, of all advanced industrial nations (3). While it ranked second to the US in its number of triadic (European Union, US and Japanese) patents, Japan’s population at 130 million is less than half that of the US. Its inventive productivity would easily exceed that of the US or the EU if the comparison were based on number of inventions per capita. Though Japan has not produced a viable challenge to the iPod, 70% of the Ipod’s semiconductor material comes from Japan. Japan does not have a prominent cell phone brand, but cell phones from Finland, the US and South Korea are packed with Japanese components. Meanwhile, Silicon Valley in the US is still struggling to recover from its 2001 implosion.

Wary of reform

A small group of Japanese companies have sought to emulate US practices, the leader of the pack being Sony, whose recent performance trails that of traditional companies such as Canon and Toyota. This is not good advertising for the shareholder-value model in Japan. The arrest in January of Takefumi Horie for alleged financial improprieties has hurt those who saw him as the kind of brash, aggressive entrepreneur needed to restore vitality to Japan. One of his main promoters was Koizumi, whose reputation has been tarnished by association.

Japan today is not the same as it was in 1990. Its economy is less regulated and more open than before. Yet its core economic institutions, both in business and in government, have changed only modestly. The reluctance to embrace change is not only found in places of privilege, such as corporate boardrooms and government offices. The average Japanese citizen is wary of reforms that will lead to higher levels of risk and inequality. Japan prides itself on its social cohesion which, although weaker than in the decades immediately after the second world war, is still stronger than in the Anglo-American world, as evidenced by measures of income inequality.

If institutional change is not responsible for Japan’s recovery, what is? An important factor is China, which has surpassed the US as Japan’s biggest trading partner. There is, however, more to the recovery than that. Japanese companies have been investing throughout Asia, and there are major new ties with India. Other factors are rising consumer confidence and investor optimism (what JM Keynes once called “animal spirits”) that feed on themselves and generate growth. Also important are government-sponsored bank mergers, which have brought the financial sector back to health, and a looser monetary policy under the guidance of the Bank of Japan’s governor, Toshihiko Fukui, who until recently pursued a zero-interest policy.

What are the lessons? One is that pundits tend to underestimate the contribution to growth of appropriate macroeconomic policies, whether fiscal policy in the US in the 1990s or monetary policy in Japan today.There has been a misguided tendency in recent years to seek an optimal set of micro- economic institutions to foster economic growth. Because the US was the fastest-growing economy in the 1990s, the unfortunate inference was that its approach to capitalism was the single best solution to the problems globalisation created for advanced industrial economies. With luck we are past the point when any single model - Japanese, European or American - is touted as the path. Instead, we should accept the fact that nations can and do pursue diverse paths to prosperity in the global economy.

Sanford M Jacoby

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Original text in English

Sanford M Jacoby is professor of management at UCLA’s Anderson School and author of ‘The Embedded Corporation: Corporate Governance and Employment Relations in Japan and the United States’ (Princeton University Press, 2004)

(3) In Japan it accounts for 3.2% of GDP, against 2.6% in the US and 2% in the European Union (statistics for 2003). See OECD, “Science, technology and industry scoreboard 2005: Briefing note for Japan”, Paris, 10 October 2005.